Keep Calm and Carry On

While reading an article about the Nobel Prize award to two American economists, I spotted a headline to the right.  It featured a link to a story CNN wrote in honor of International Day of the Girl.  Titled “To my 15-Year Old Self:  Things I Wish I’d Known,” the writer posed that question to notable women in a variety of fields.  The link showed a picture of Oprah, because you always have to ask her those sorts of questions.

I find her rather annoying, so, naturally, I clicked the link.  The problem I have with her is she seems out of touch.  It is easy to talk about “living your truth” and “risking everything to pursue your passion” when you are a multi-billionaire for whom the risks brought great reward.  Do you think the person who just lost everything when his/her business collapsed feels happy and fulfilled because they “followed their dream?”  Doubtful.

Anyway, as I read the quotes from these highly successful ladies, it occurred to me that living in the past can be a dangerous thing.  Sure, it is good to look back and say, “Oh, I really wish I had not done that.”  On the other hand, you can become so paralyzed by fear of making the same mistake that you take no action at all.  The key is to learn from the mistake and get on with your life.

We can do that in our portfolios too.  There was a time when I was reluctant to invest excess cash in my portfolio because of current market conditions.  As a result, I missed out on some of the upticks in the market.  The lesson I learned is emotion has no place in investing. 

You may have similar feelings now with the upcoming election.  What happens if Obama is re-elected?  What would Romney do if he becomes President?  Will this country fall into a Great Depression or have a huge economic boom?  No one knows.  However, I would bet that, if you looked at previous elections, similar comments were said about the president and candidate then.  It happens with every election.  Work the crowd into a frenzy so they will watch the news.

We cannot change the past.  We cannot predict the future.  Let’s focus on what we can control (our behavior), keep calm, and carry on.

Cristy Freeman, AAMS
Senior Operations Associate

Share this:

The Fiscal Cliff, Taxes and Investment Decisions

This morning CNBC had a headline “Fending off the Fiscal Cliff”.  I turned off the TV.  You have to beware of headlines that create a sense of urgency to do something in your portfolio.

This sort of reporting promotes what I call the “I’ve got a feeling” trade.  This is when you take some action in your portfolio based on the mood of the day. Currently, there is a lot of focus on the Presidential election.  If you are concerned about the other candidate winning, keep in mind that someone is equally concerned about your candidate winning.  Don’t make investment decisions based on emotion.

Taxes can be a factor, but should not be the sole driver of an investment decision.  Tax planning for this year is particularly difficult due to the uncertainty of future tax rates.  The Bush tax cuts are set to expire on 12/31, which would cause the tax rate on qualified dividends to increase from a current maximum of 15% to as high as 39.6%, depending on your tax bracket.  We likely will not know anything on income tax, estate tax, alternative minimum tax, the possible return of the IRA charitable deduction for those over 70.5, etc. until after the election or even later in December.  It’s also possible that these tax rates could be finalized in the first quarter of 2013 and made retroactive to 12/31.

This year is unusual in that some of the usual rules of thumb about capital gains may not apply.  Typically, people want to delay paying taxes whenever possible.  However, you way want to realize some long-term capital gains in 2012 in order to lock in the 15% tax rate which will likely be higher next year.  In addition, capital gains rates are currently 0% for taxpayers who are in the 10% or 15% tax brackets based on their taxable income.  The 0% tax rate for these people also expires on 12/31/2012.

You may not want to realize capital gains early under certain circumstances.  For example, if you have investments that are highly appreciated and you are advanced in age or in poor health.  Depending on the size of your estate and what happens with estate tax law, the beneficiaries of these assets may receive a step-up in basis for all or a portion of the assets upon the taxpayer’s death.   Therefore, it wouldn’t make sense to sell assets and pay taxes on the gain when a step-up might be available in the near future.

We recommend that you avoid making major decisions or changes to your portfolio based on fears or possibilities that may or may not materialize. While some limited amount of portfolio rebalancing may make sense, you should discuss your particular situation with your Parsec advisor if you have questions.

Disclaimer:  we are not licensed CPAs and do not give tax advice.  We offer some general guidance with respect to the mechanics of tax issues, but we encourage you to consult with your CPA or a qualified tax professional before making any decisions or taking action.

Bill Hansen, CFA

Managing Partner

October 12, 2012

Share this:

A Little Contrarianism Can Be a Good Thing

In our most recent quarterly letter, we reiterated our belief that you should allocate 15-25 percent of your equities portfolio to international stocks. Some of our clients still question the logic of this position in light of the ongoing EU crisis. However, let me make a case for contrarianism.

While the pall hanging over Europe has worsened in the last few years, things have not been rosy for a long time. According to June 2, 2012 article published by The Economist ( ):

Robert Buckland, an equity strategist at Citigroup, points out that about 44% of pan-European corporate profits are generated outside Europe (British companies earn 52% of their profits outside the continent). Around 24% of European profits come from emerging markets, roughly double the exposure of American companies to the developing world.

This diversification is not a coincidence. European companies have already endured a decade of sluggish growth and have sought out markets elsewhere (for production as well as sales).”

This indicates that worsening conditions in Europe will compel European companies to expand even further into the global economy. And, our dividend yield loving clients have another good reason not to flee European investments. While the average dividend yield for American markets is 2.2%, European markets are yielding 4.1%.

Beyond Europe, emerging markets continue to provide opportunities for investment. Mongolia is enjoying a rapidly expanding economy thanks to a boom in coal and copper mining. The Arab spring has led some analysts to predict major growth in Libya. A return to oil production and distribution is giving Iraq’s economy a much needed shot in the arm. Additionally, economists see much opportunity for growth in Africa, with several countries expected to post growth rates in excess of 7.5%.

I am not suggesting that European markets have hit bottom or that you should put all of your international investment dollars in emerging markets. What I do espouse is that a well diversified portfolio for the long-term investor has some exposure to international equities, even when the headlines indicate otherwise.

Tracy H. Allen, CFP®

Financial Advisor

Share this:

Scared Money Don’t Make Money

Recently, I heard the above phrase in a rap song by Pitbull.  I was surprised to hear mention of investment risk/reward in a popular song.  He did not go on to discuss European economic instability or currency valuation.  That would have been truly shocking.

The statement provokes thought, though.  People who are willing to take the most risk have the potential for greater reward – and greater loss.  It is easy to have an asset allocation of 100 percent equities in an up market.  Can you keep that allocation when the market is significantly down?  Will you still sleep at night?

On the other hand, holding money in a money market fund earning near-zero interest is also a risky proposition.  You must find some vehicle in which to invest because you cannot afford to earn nothing for your money.  Inflation continues to rise, even when interest rates are not.  The dollar you stash in a mattress will not be worth the same 10 years from now as it is today.

Finding the right allocation is very tricky.  It requires a great deal of evaluation on your part.  What is your current age?  Do you have enough time to recover from a short-term loss?  What are your investment goals for the next 5, 10, 15 years?  When do you want to retire? 

This is just a sample of some of the questions you should ask yourself.  A thoughtful review of your situation with your investment advisor will help the two of you to determine the best asset allocation.  Being brutally honest with yourself and communicating your goals, thoughts, and concerns with your investment advisor will allow you to work as a team.  The two of you will be able to find the right allocation that can help you sleep a little better at night.

Cristy Freeman, AAMS
Senior Operations Associate

Share this:

I’m the Wiz and Nobody Beats Me!

I heard an interesting piece on NPR the other morning while I was driving to work. It was about the power of perception – in this case, how it relates to golf. A researcher at Purdue University did an experiment using an optical illusion to change the appearance of the golf hole. She found that, even when the holes were exactly the same size, participants were more likely to sink the putt when they perceived the hole to be bigger than it actually is. Here is an example (it’s called the Ebbinghaus illusion):


The conclusion is that with positive perception comes confidence. However, confidence alone won’t guarantee top performance, at least not in sports. And not in finance, either – the piece reminded me of something psychologists call overconfidence bias. Basically, people have a tendency to believe their predictions are far more accurate than they actually are. And the interesting thing is, the more a person is considered an “expert” the higher their level of overconfidence. Their increased knowledge of a particular topic leads them to believe they are correct far more often than they actually are. Even better, researchers who have studied this phenomenon find that the worst performers tend to be the most overconfident. And of course, if you were to ask a panel of experts to rank themselves against their peers in terms of their abilities, each would most likely rank himself as above average. The same way everyone is an above average driver, or has a good sense of humor, right? It’s statistically impossible, but there you have it.

So if the experts don’t have good predictive abilities, why do we use analysts’ forecasts at all? Well, you have to start somewhere. Psychologists call this anchoring – the need to grab hold of something in the face of uncertainty. When we review a particular company’s equity, we study a variety of research reports and consensus estimates. Sometimes the predictions vary widely, other times the range is pretty tight. We start with these and run different scenarios, in the belief that the outcome will lie somewhere between the best- and worst-case. We always view the analysts’ estimates with a critical eye and make adjustments for those that seem overly optimistic, in order to predict a more realistic outcome. Of course, this is also why we are strong advocates of a well-diversified portfolio – we know that predictions are only that, and anything can happen. Proper diversification dampens the effect that an unforeseen negative outcome in any one security will have on the portfolio as a whole.

The good news is, you can improve your putting with a little optical illusion. Feel free to take a little cutout of small circles to overlay the hole next time you go. Nobody will think you’re crazy or anything.

Sarah DerGarabedian, CFA

Director of Research

Share this:

Is It Priced In?

In our investment process, we often have to ask ourselves this question.  Something bad has happened to a company or market; does the current price reflect the news?

Years ago, when I was an undergraduate finance student, the Efficient Markets Hypothesis (“EMH”) was popular and taught at virtually every university.  The debate wasn’t about whether it applied or not, but rather to what extent.  I have summarized the three “forms” of the EMH below:

Weak Form:  Stock prices reflect all historical information.  This means that past prices give no predictive information as to future prices.  The implication is that technical analysis, such as studying chart patterns, or the “support” and “resistance” levels you hear about in the media, are worthless.

Semi-Strong Form: Stock prices reflect all publicly available information.

Strong Form:  Stock prices reflect all information, whether publicly available or private (i.e. insider).  In a strong form world there would be no such thing as insider trading.  Why? It would not be profitable, since all information has already been reflected in the current stock price.

In my classes, pretty much everyone agreed that the weak form held, and that charts were worthless.  The debate was between semi-strong and strong.  At the time, my personal view was that reality was somewhere in between the two. 

After the last two stock market crashes, many began questioning the EMH and whether it is valid at all.  Today, high frequency traders make millions of trades per day based on computer models driven largely by past data.  If the weak form of the EMH held, there would be no profit in this type of strategy.  Now I believe there is another factor to the EMH:  time.  Markets are reasonably efficient in the long run, however, prices may become disconnected from the underlying value of a company or market for a period of time.

Stock prices adjust almost instantaneously to news.  Markets are forward-looking, meaning price changes really are about changes in future expectations.  Company XYZ reports earnings ahead of consensus expectations, but the stock price falls.  Why is that?  Management may have adjusted future earnings guidance lower or just sounded more pessimistic about the next few quarters in the future.  This causes market participants to adjust their expectations (and the price) downward.   Some companies have grown tired of this short-term focus, and refuse to even give guidance regarding their earnings.

So is it priced in?  The answer is sometimes.  The art is in determining when this is the case and when the consensus is wrong.  We address this by having a disciplined investment process focused on fundamental data, and ignoring short-term noise.  Our focus is on financially strong companies that are likely to have rising earnings and dividends over time.  However, working with our clients to determine an appropriate asset allocation that suits their individual situation and having the discipline to stick to it is even more important to investment success.

Bill Hansen, CFA

Managing Partner

March 30, 2012

Share this:

The Asset Allocation for College Funds

Asset allocation, the proportion of stocks, bonds and cash in a portfolio, is one of those topics that financial advisors think about constantly.  Because we have clients with such a variety of needs and changing financial scenarios, we are always working with someone to help them find the appropriate investment allocation for their personal situation.  For the typical investor however, it shouldn’t be so hard.  Once you’ve chosen the appropriate allocation, you should stick with it as long as your financial or life circumstances haven’t changed much.  This type of “set it and forget it” mentality is the mark of a disciplined investor.

But what about the asset allocation for a college fund?  For a newborn child you only have 18 years before you have to pay out a significant portion of the fund, which you will then deplete over 4 years.  If you start saving later, the time frame is even shorter.  This is very different from a retiree who will often have a longer time frame than 18 years.  Also, for a retiree, typically the intention is to spend around 4 to 5% of the retirement portfolio value every year, so that the retirement funds continue to grow over time.  This isn’t the case with a college fund.  It can be both long-term (18 years to grow) and short-term (all paid out over 4 years) at the same time.  It makes the asset allocation decision a conundrum.  Now throw in the fact that somehow children grow up faster than you can possibly imagine and each year the time until payout grows exponentially closer, requiring more frequent allocation tinkering.

If you are able to save when your children are babies, the allocation decision is fairly easy.  With an above-average risk tolerance you might choose 100% equities.  Once kids are in their teens though, you could switch to a more conservative allocation with a mix of stocks and bonds.  As they approach their final year of high school, you could move to all fixed income.  There is no easy solution here, and often it depends on the parents outside resources.  If the parent is entirely dependent upon the college funds to pay for college, the fund should be more conservative as they approach age 18.  The give up is potentially less money for college if the stock market is doing well during these years.

If you have multiple children with 529 plans for each, and outside resources in addition to this, you may choose to stay with a higher equity allocation.  If the stock market doesn’t perform well during the college years, the parent could choose to pay some expenses out of pocket and then roll any excess 529 funds to younger siblings.

Regardless of the allocation you choose, you are taking a risk.  If you’re too conservative you may not have enough money to pay for college.  Conversely, if you’re too aggressive, you stand the chance of losing money you’ve saved all along just at the time that you need to withdraw it.  My advice is to discuss the allocation with your financial advisor.  Your risk tolerance will be the main driver in this decision.  Other important factors will be outside resources for paying for college, as well as your family’s unique circumstances.

Harli L. Palme, CFA, CFP®

Financial Advisor

Share this:

Pepperoni Math

So here’s the setup: you have two large pizzas. One is cut into four pieces, the other is cut into eight pieces. Would you rather have one piece from the former, or two pieces from the latter? If you asked a hungry four-year-old that question, he’d probably be totally confused because you used the words “former” and “latter.” But then he’d go for the 2 pieces because in his mind, two pieces are more than one. Of course, anyone with a basic knowledge of fractions knows this is a trick question, because it’s the same amount.

Let’s imagine now that the pizzas are companies, and the pieces are shares of stock in those companies. You have $1000 to invest. Company A’s stock price is $50, and company B’s stock price is $100. Assuming that there are no trading costs, you can purchase 20 shares of company A and 10 shares of company B. All else equal, which would you buy? Answer: it doesn’t matter – your investment in either company is the same. Really. You’d be surprised at how many otherwise intelligent people would choose company A because you get “more” shares of stock or because they think the shares are a better “value” by virtue of having a lower price per share. The thing you have to realize is this – a company can issue any number of shares it wants to. If the price per share is $100 they can issue a 2-for-1 split, and now you’ll have 2 shares worth $50 each for every one you had before. Your total dollar investment in the company doesn’t change, though.

As for value, that’s a somewhat more complicated issue to address, but the concept of value in the world of equities is not very different from the way you’re used to thinking of it. It comes down to whether you’re paying a reasonable price for the thing you’re buying. Let’s take a pair of shoes, for example. A well-made pair of shoes will cost more than a cheaply made pair. Between two similarly well-made pairs, though, one may cost more than the other due to some kind of intangible, like a brand name. You can pay up for the brand name, or you can buy the other pair because you recognize it’s a good value for the quality. They’re still more expensive than the cheap pair, but thanks to superior materials and workmanship they should hold up longer and are the better investment despite their higher price. See where I’m going with this? Stock price by itself tells you nothing about the underlying investment, and it’s not the stick by which value is measured.

So how is value measured? That, my friend, is a topic for another time. Right now it’s a beautiful Friday afternoon in October, and my mind is already gone. Maybe my body will join it for a pizza.

Sarah DerGarabedian, CFA

Director of Research

Share this:

Be Greedy When Others are Fearful…

This is an essential part of Warren Buffet’s investment strategy.  The idea is that most investors, as emotional human beings, are wrong when it comes to the stock market.  Interestingly, when the stock market goes down, the number of calls we receive increases.  When the stock market is going up, the phones are quieter.  In down markets, we spend a great deal of time reassuring clients about maintaining the asset allocation that suits them, and not making dramatic changes based on the mood of day or what they see, hear or read in the mainstream media.  It is particularly difficult to maintain a cool head when markets are volatile, and in August we have had several of the most volatile days in the past 50 years (most of them down).  But that is the time when maintaining your composure is even more crucial.

As of this writing, the market is down about 17% from its high in April. It is up about 68% from the low on 3/9/09.  This is referred to as a “correction,” or a decline of more than 10% but less than 20% from a previous peak.  Corrections are not unusual, particularly after a big advance, and have happened on average every 2-3 years since the end of Word War II.

While no two corrections are exactly the same, we can examine historical data to see what has happened in the past.  There is an old saying, which many attribute to Mark Twain, “History doesn’t repeat itself, but it does rhyme.”  The current correction began in late April and has lasted about 3.5 months, with a recent low on the S & P 500 of 1119 set on August 9.  Looking at the average since 1945, corrections have taken about 4 months to go from peak to trough and an additional 4 months to regain their previous peak.

A “bear market”, or decline of more than 20% from a recent high, has historically happened less frequently and had a longer recovery time. We do not believe we are going to experience a bear market, but are fairly close to that level of about 1090 on the S & P 500. 

Yesterday the yield on the 10-year US Treasury Note fell below 2% briefly, the lowest level since the Eisenhower administration in 1954.  Several of the companies that we invest in have current dividend yields of 3% or more, and have raised their dividends each year for 30, 40 or even 55 years.  If asked whether I thought their dividends next year will be higher or lower, I would say higher.  Stock prices eventually follow growth in earnings and dividends (the key word being eventually).  Most economists are forecasting slow but positive economic growth this year, and better growth next year.  We believe stocks, particularly high-quality, dividend-paying companies, are currently very attractively valued relative to bonds and other assets such as gold.  While high-quality companies have lagged somewhat in performance off of the 2009 market bottom, we are seeing many such companies with good and rising dividends and earnings.  We believe that a diversified portfolio of such companies will position our clients well as economic growth continues to improve.

 Bill Hansen, CFA

August 19, 2011

Share this:

Stock Market Volatility

It’s been a wild week for stocks.  Not only are stocks down roughly 9% from the end of July as of the close of market August 11, but the pathway down has been marked by extreme volatility.  This month we have experienced six of the 200 most volatile days of the past 50 years.  We have had daily losses of 2.5 – 6.6% and have had daily gains of greater than 4.5%.  These losses were kick started with the political wrangling of the debt ceiling, and were intensified with the ensuingU.S.debt rating downgrade by S&P.  The market losses and volatility are leaving many investors uncertain about the state of the economy and their portfolios.  We offer three scenarios to consider – base-case, worst-case and best-case – and their potential effects on the stock market.

The base-case scenario is the one that we consider most probable, and that is continued slow-growth in the near-term, with eventual normal growth resuming in the long-term.  We’ve seen two quarters of slow growth already, 0.4% for the first quarter of 2011 and 1.3% growth in the second quarter of 2011.  Slow growth quarters are historically not useful predictors of recessions.  Given our fragile economy, such slowing may induce the Federal Reserve to engage in more economic-stimulating measures.  We recognize that an offset to these growth stimulators are high, though slightly improving, unemployment, as well as global political and fiscal uncertainty.

Despite a slow-growth economy, corporate earnings are at an all time high, with expectations that S&P 500 earnings this year will be $100 per share.  This puts the stock market at about an 11.5 price-to-earnings ratio, far below its historical average of 15.  For this reason, we don’t see a catalyst for a further, significant, sustained drop in stocks.

The worst-case scenario is another recession.  Reasons for this possibility are well known:  tax uncertainty, high unemployment, nervous consumers.  General panic is not known to cause recessions, though some fear this could become a self-fulfilling prophecy.  Panic does indeed affect stocks however, which is what we are seeing currently.  Stocks are known to be a leading indicator of recessions.  When recessions do occur, the median historical market peak is about 7 months prior to the start of the recession.  But typically once you know you’re in a recession, it’s actually time to buy stocks.  In fact, the recessions of 1953 and 1990 saw stocks go straight up.

The best-case scenario is the resumption of robust growth.  The record corporate earnings may spur business and investor confidence.  There is said to be pent-up consumer demand waiting to be unleashed at the suggestion that still on the road to recovery.  Too, oil prices have come down considerably.  You may recall that just a few months ago high oil prices were a huge concern for the economy, as this necessary product would hamper other consumer spending.  And though theU.S.debt downgrade has spooked the stock market,U.S.treasuries, the very debt that was downgraded, have actually rallied.  This is because, in the end, investors still believe in the strength of theUnited States.

Our Chief Economist, Jim Smith, predicts year-over-year GDP growth of 1.9% for 2011 and 3.9% for 2012.  Whatever the economic outcome over the next few months, we must accept that our economy is a cyclical one, in which we experience recessions and expansions.  Long-term growth of GDP and corporate earnings leads to long-term appreciation of stocks.  Being a buyer and holder of equities gives you the ability to participate in this long-term growth.

We believe that to be a successful investor in stocks you have to accept the volatility, and the uncertainty that surrounds it.  Corrections and bear markets are part of the territory.  As an investor, it’s tempting to believe that you have the ability to guess the timing and direction of stocks, but attempting to do so is hazardous to your financial health.

Harli L. Palme, CFP®

Financial Advisor

Share this: